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Tenet's Turn for Worse

The stock tumbles as turnaround doubts intensify.

OKLAHOMA CITY --

Tenet's

(THC) - Get Report

vital signs are in decline.

An analyst who has long been skeptical about the hospital chain grabbed investors' attention recently by saying he isn't sure Tenet can survive. Credit Suisse analyst Kenneth Weakley began coverage of Tenet last week with an underperform rating, predicting that the stock -- already at a two-decade low -- could fall to $2 in the next year and become essentially worthless down the road.

"We would argue that no tangible evidence supports a turnaround thesis at this point, as almost every important metric for hospital operations fails to show a sign of recovery," wrote Weakley, whose firm makes a market in the company's securities. "Therefore, we view THC not as a turnaround story but as one that is still very much in secular decline."

Tenet fired back that it is in good enough shape to execute a long-promised turnaround, but Wall Street clearly has its doubts. Shares hit a 52-week low of $3.23 at midweek before staging a modest recovery heading into Labor Day.

But even beyond the recent negative comments from longtime critic Weakley, Tenet fans have many issues to mull over. For starters, even hospital industry leaders such as

Universal Health

(UHS) - Get Report

find themselves struggling in a tough economic environment.

Now, some observers are pointing to a lease dispute involving some of the Tenet's core hospitals as another sign of potential problems.

In its latest quarterly report, Tenet noted that landlord

Health Care Property Investors

(HCP) - Get Report

claims Tenet has defaulted on a number of leases.

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HCPI says Tenet has failed to properly maintain three hospitals -- including one that faces expensive seismic upgrades -- and has cross-defaulted on four additional hospital leases as a result. HCPI has therefore demanded that Tenet turn over possession of the hospitals by the end of this year.

Tenet insists that HCPI's claims have no merit and says it plans to vigorously defend its stand in court. Many experts, including some of Tenet's own critics, feel that the company may be right.

But some believe HCPI's unusual move suggests that it, like Weakley, wonders if Tenet may soon find itself in deep trouble on the liquidity front.

"HCPI is playing real hardball; this is not something you do in the ordinary course of business," says a major Tenet short-seller. "They're worried about getting their rent payments, which can be forestalled during bankruptcy. ... I think they know that Tenet cannot survive."

Even before recent setbacks, some observers had already started worrying about a looming liquidity crisis for the company.

Tenet has been trimming its forecasts for cash flow -- as measured by earnings before interest, taxes, depreciation and amortization -- as the hospital industry continues to struggle with the rising cost of care and a heavy flow of uninsured customers. Meanwhile, Tenet has pledged to spend $675 million to $725 million -- or virtually all of its projected EBITDA -- on capital projects this year.

But the company faces huge interest payments to cover its hefty debt load as well. Thus, within a year, some experts expect the company to start tapping its credit line just to fund its operations.

"Tenet appears to have entered a capital-preservation mode, in our view," Stanford Group analyst Gary Lieberman, who rates the stock sell and has a $3 price target, wrote last month. "Tenet's capital flexibility continues to deteriorate. ... At this point, we believe it is unlikely that Tenet has the financial capacity to turn its operations around."

Still, Tenet leaders themselves seem to see a bargain. In recent weeks, the company's three top officers have all scooped up thousands of shares of stock at record-low prices. A couple of hospital analysts have recently upgraded the stock from sell to hold, seeing little risk of downside, as well.

"We believe we have the financial resources to execute our turnaround," Tenet CFO Biggs Porter stressed last Wednesday. "Also, in addition to our cash on hand and bank credit line, we would have the ability -- although it is not anticipated -- to tap the credit markets using our asset base."

Some people wonder if Tenet could try to sell some of its hospitals to raise cash. But to a potential buyer, the selection might look grim.

Tenet operates 18 hospitals in California, a market challenged by high unionized labor costs and looming earthquake upgrades. The company also runs a dozen hospitals in Florida and another dozen in Texas, the two states with the highest uninsured rates in the country.

To be fair, Tenet owns 15 hospitals -- some of them quite profitable -- in other markets. But those hospitals alone could doubtfully generate enough cash to cover Tenet's huge interest payments and keep the company afloat.

"As long as management continues to spend as much in cap-ex as it generates in EBITDA, cash flow will be negative each year by at least the $400 million annual interest cost -- and that leaves little room for weaker industry conditions," Gimme Credit bond analyst Vicki Bryan warned on Friday. "Without additional tax refunds, stepped up asset sales at better prices and friendly bankers, THC could exhaust its cash and credit line over the next three years."

Bryan therefore has an underperform rating on Tenet's senior notes, despite their recently falling prices.

Even CRT Capital analyst Sheryl Skolnick -- a rare Tenet bull who likes the company's bonds and, moreover, believes its stock can double in two years -- feels a pressing need for action. In a recent research note, Skolnick offered up a list of possibilities, starting with management changes and including further asset sales or a complete break-up of the company.

"While none of these strategies are particularly earth-shattering or novel," Skolnick admitted after the company's second-quarter update, "we would hope that THC's board would become more visible in taking steps to enhance the value of the company -- and soon, as we see the post-earnings share price movement as a clear signal of the present dangerous mood of the company's shareholders."